Government Securities Act 2006 and the Investment Portfolio of Banks

Lending gets the attention, but between a quarter and a third of a typical Indian bank's assets are not loans at all. They are investments, overwhelmingly securities of the Central and State Governments, held partly because the law compels it through the statutory liquidity ratio and partly because a bank needs a stock of assets it can turn into money in an afternoon. Two bodies of law govern this half of the balance sheet: the Government Securities Act, 2006, which says what the security is and how it is held and transferred, and the Reserve Bank's investment directions, rewritten with effect from 1 April 2024, which say how the portfolio is classified and valued.

1. The security itself: the Government Securities Act, 2006

The Act of 2006 replaced the Public Debt Act, 1944 for the securities of the Union and the States, and it is administered by the Reserve Bank as the manager of the public debt, a role that comes from Section 21 of its own statute. A government security is a security created and issued by the Central or a State Government for raising a public loan, in the forms the Act permits.

Figure 1: How the security is held, and what the form carries

• The dominant form is the subsidiary general ledger account, a book entry ledger maintained with the Reserve Bank by banks, primary dealers and other eligible institutions, with a constituents' subsidiary general ledger beneath it for holdings on behalf of customers. Transfer is by book entry, and under Section 4 the holder of the account is deemed to be the holder of the securities in it.
• Section 3 recognises four forms, the Government promissory note, the bearer bond, stock and the bond ledger account, and the Act permits conversion between forms and provides machinery for title on death, including nomination by individual holders under Section 9, recognition of survivors, and summary recognition of title to a deceased holder's securities without a succession certificate up to ₹1 lakh, a limit the Central Government may raise to ₹1 crore, under Section 7.
• It deals with the misfortunes of paper: under Section 11 the Reserve Bank may issue duplicates of securities lost, stolen, destroyed, defaced or mutilated, and may convert, consolidate, sub-divide or renew them.
• Because ownership of a ledger holding is the entry itself, attachment and enforcement against a government security follow the entry rather than any document.

Figure 2: The life of a government security

2. Why banks hold so much of it

1. Compulsion. The statutory liquidity ratio under Section 24 of the Banking Regulation Act, 1949 requires a slice of net demand and time liabilities to be held in liquid assets, in practice government securities.
2. Liquidity. The liquidity coverage ratio needs high quality liquid assets, and nothing else in India is as deep; the same stock is what the bank repos to the Reserve Bank when it needs money tonight.
3. Capital. Rupee claims on the Government carry a zero risk weight, so the portfolio consumes no credit risk capital, though it consumes risk appetite of another kind.
4. The risk it does carry is interest rate risk. A bond's price falls when yields rise, and a bank holding long bonds against short deposits is running the mismatch that the classification framework exists to make visible.

3. The classification framework from 1 April 2024

The Reserve Bank's Classification, Valuation and Operation of Investment Portfolio of Commercial Banks Directions, 2023, issued on 12 September 2023 and effective from 1 April 2024, replaced a framework that had stood since 2000 and aligned the books with how the rest of the world accounts for securities. Classification happens on the day of acquisition, by two tests: the bank's objective in holding, and whether the instrument's cash flows are solely payments of principal and interest.

Figure 3: Three categories, and what each does to the accounts

• Held to maturity: securities with ordinary principal and interest cash flows, acquired with the intention and ability to hold to maturity. Carried at cost, never marked to market. The old ceilings are gone: there is no longer a cap on the share of the portfolio, or of statutory liquidity securities, that may sit here.
• Available for sale: the home of securities that pass the cash flow test but may be sold. Fair valued at least quarterly, with the gains and losses accumulated in a reserve within equity, reaching the profit and loss account only on sale. The old investment reserve account is discontinued.
• Fair value through profit and loss: everything that fits neither, including instruments with equity-like cash flows, with held for trading as a subcategory aligned to the trading book, valued daily, the rest at least quarterly, all changes passing through profit.
• Subsidiaries, associates and joint ventures stand outside the three, at acquisition cost, tested for impairment.
• Sales out of held to maturity are the policed frontier: they require a board approved policy, and beyond a small tolerance the bank must disclose the sales in its accounts, because a category that is never marked to market is honest only if it is truly held.
• An investment fluctuation reserve continues, built from trading gains, as the cushion against the day the cycle turns.

4. The questions this portfolio decides

• Earnings volatility. The split between the categories decides how much of a yield move reaches the profit and loss account this quarter, which is why treasury classification is a board level matter and not a back office one.
• The sovereign nexus. A banking system holding a large stock of government debt ties its own health to the sovereign's, the loop that international regulation keeps debating; the zero risk weight is a policy choice, not a law of nature.
• Monetary transmission. Banks' appetite at the auctions is what absorbs the Government's borrowing, and the Reserve Bank's open market operations work by moving the price of the very stock the banks hold.
• Collateral for everything. The same securities stand behind the repo market, the liquidity facilities, intraday credit in the payment systems and the margin at the clearing corporation; the portfolio is the system's common pool of collateral.

5. Quick Revision

1. A government security in ledger form transfers by book entry, the account holder being deemed the holder of the securities.
2. The Act of 2006 lets survivors and nominees take without a succession certificate within limits, like the banking statute it parallels.
3. Classification is fixed on day one; reclassification is the exception, with the Reserve Bank's approval.
4. Available for sale gains and losses now pass to a reserve within equity, where the old rule provided for net depreciation and ignored net appreciation.
5. Interest rate risk, not credit risk, is what the portfolio carries.

6. Frequently Asked Questions

Why was the ceiling on held to maturity removed?

Because it had stopped doing its job and was doing another one badly. The ceiling existed to force banks to mark most of the portfolio to market, so that rate risk showed in the accounts; in practice it was raised whenever the Government's borrowing programme needed absorbing, which turned a prudential rule into a debt management lever. The directions of 2023 replaced the ceiling with conditions: only plain principal and interest instruments may enter, intention and ability to hold must exist on day one, and exits are disclosed beyond a tolerance. The shelter became honest instead of rationed, and the quid pro quo is that what sits outside it is now fair valued without the old softening devices.

If government securities are risk free, how did rising yields hurt banks?

They are free of credit risk in rupees, not of price risk. A bond promising fixed coupons falls in price when market yields rise, and the longer its remaining life the further it falls. A bank that bought long bonds when yields were low holds assets worth less than cost the moment the cycle turns, and if those bonds sit in a fair valued category the loss lands in the accounts at once. The international bank failures of 2023 were exactly this: portfolios of impeccable credit, funded by deposits that ran, sold at depressed prices to meet the running. The classification framework cannot abolish that risk; its job is to stop it hiding.

What is the subsidiary general ledger, in plain terms?

The Reserve Bank's register of who owns the Government's debt, kept as accounts rather than certificates. A bank or primary dealer holds a principal account in its own name, and a constituents' account through which it holds, segregated, for customers who cannot hold directly, a mutual fund, a pension trust, a cooperative bank. Ownership moves by book entry when trades settle through the clearing corporation, the account holder is deemed the holder of the securities, and they never exist as paper at all. The retail direct platform of 2021 extended the same idea to individuals, who may now hold a gilt account with the Reserve Bank directly and bid in auctions without an intermediary.

Can a bank sell from held to maturity if it needs liquidity?

It can, and the framework is built so that it rarely has to. For liquidity the natural route is repo: the bank borrows against the securities, under the market's documentation or from the Reserve Bank's facilities, and the holding never leaves the category. An outright sale from held to maturity is lawful under the bank's board approved policy, but beyond a small tolerance the sales must be disclosed in the notes to accounts, and a pattern of selling tells the market and the supervisor that the intention claimed on day one was not real, inviting reclassification of the book. The category shelters patience, not convenience.

Does the Retail Direct scheme change who owns the gilt market?

Slowly, and at the margin, but the legal plumbing matters more than the volumes. Since 2021 an individual may open a Retail Direct gilt account with the Reserve Bank itself, bid non-competitively in the auctions, and buy or sell on the secondary platform without a bank or broker in between. The account is a constituent style record maintained by the Bank, so the investor takes the Government Securities Act's machinery, book entry title, nomination, survivorship, directly rather than through an intermediary's omnibus account. For the examiner the point is structural: the statute of 2006 was drafted for a wholesale market of banks and funds, and Retail Direct shows the same legal forms carrying a retail market without amendment, which is the test of good property law. Ownership of the market itself still rests with the banks, bound by the statutory liquidity ratio, the insurers and the provident funds bound by their investment patterns; what the scheme changes is that the sovereign now has a direct retail window in its own debt, and the citizen a custody relationship with the central bank itself.

7. Related Topics and Provisions

• The money market and inter bank dealings
• Instruments of monetary control and open market operations
• Capital adequacy and the Basel framework in Indian banking
• Banker to the Government and manager of the public debt
• Financial stability and the resolution gap